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December I, 1989 4 percent. Barring a shift in the relation- • ship between M2 and nominal GNP growth, a period of disinflation may lie ahead. 1. See the Federal Reserve Bulletin, any and a Test of the Quantity Theory of The current target range permits ample opportunity for the inflation rate to decline during the next few years. M2 growth would have to be maintained at 7 percent in the future, the upper limit of the range, just to maintain the current inflation trend. The pause in the gradual reduction of the target ranges for 1990 does not imply less commitment to price stability; rather, growth near the midpoint of the current 3 to 7 percent target range would be consistent with further declines in the rate of inflation to about 2 percent, or half of its recent trend. Footnotes recent issue, for definitions of the monetary Money," Working Paper 89-2, Federal aggregates. Generally, M I includes balances Reserve Bank of Richmond, April 1989; and used in making transactions, while M2 in- Robert H. Rasche, "P-Star Type Models: cludes M I plus household savings assets. Evaluation and Forecasts," manuscript, M3, the broadest measure, adds to M2 other Michigan State University, September 1989. liquid assets that are held mostly by large For a less technical description of this work, asset holders. see John B. Carlson, "The Indicator P-Star: 2. The federal funds rate is indirectly, but Just What Does It Indicate?" Economic Com- closely, controlled by the Federal Reserve over periods as short as a month or even a week. The discount rate is set directly by the Board of Governors of the Federal Reserve S. Congressional testimony of Alan Greenspan, Chairman, Board of Governors of the System. Federal Reserve System, July 20, 1989,1989 3. Congressional testimony of Alan Green- Monetary Policy and the M2 Target Monetary Policy Objectives, ~ I p. I. by Susan A. Black and William T. Gavin I span, Chairman, Board of Governors of the Federal Reserve System, July 20, 1989, 1989 Hi;toriCallY, the monetary targets have been used both as a way to signal intentions about long-term policy goals and as a guide for short-term policy actions. I The Federal Reserve has never Monetary Policy Objectives, p. 4. 4. See Robert F. Engle and C.W.J. Granger, "Cointegration and Error Correction: Repre- Susan A. Black is an economic analyst and sentation, Estimation. and Testing," Econo- William T. Gavin is an assistant vice presi- metrica, March 1987.55. dent and economist at the Federal Reserve pp. 251-76. They show that. of all the official monetary aggre- 1990 target ranges at its February 1990 meeting. M2 growth has been averaging nearly 7 percent for the past few months and is expected to continue growing that rapidly. For the FOMC to gates, only M2 shares a common trend with factors become relevant and compel the FOMC to override the signal from M2 remains to be seen. Federal Reserve Bank of Cleveland mentary, Federal Reserve Bank of Cleveland, September IS, 1989. The FOMC will reconsider its tentative maintain M2 growth along a disinflationary track, a tightening of monetary policy would be necessary to constrain M2 to its midpoint. Whether additional eCONOMIC COMMeNTaRY April 1989; Yash P. Mehra, "Cointegration nominal GNP. Recent studies that investigate this result include Jeffrey J. Hallman, Richard D. Porter, and David H. Small, "M2 Per Unit of Potential GNP as an Anchor for the Price Level," Staff Study No. 157, Board of Governors of the Federal Reserve System, Bank of Cleveland. relied solely on the monetary targets to guide policy in the near term, however. The amount of emphasis has varied, first rising as pol icymakers became more concemed about inflation and later fall- The views stated herein are those of the authors and not necessarily those of the Federal Reserve Bank of Cleveland or of the Board of Governors of the Federal Reserve System. ing as evidence mounted that money demand was becoming unpredictable. April 1989; Dennis Hoffman and Robert H. Rasche, "Long-Run Income and Interest Elas- From late 1984 until the summer of ticities of Money Demand in the United States," NBER Working Paper No. 2949, 1989, M2 was the Federal Reserve's primary monetary target, but apparently Iittle attention was paid to it as a near-term guide for policy. M2 targets may still be important, however, as a signal of long-term policy intentions. Federal Reserve Bank of Cleveland Research Department P.O. Box 6387 Cleveland, OH 44101 Address Correction In 1985 and 1986, the Federal Reserve set a target range for M2 of 6 to 9 percent. The target range was lowered BULK RATE U.S. Postage Paid Cleveland,OH Permit No. 385 each succeeding year until July 1989, when the preliminary targets were chosen for 1990 (see table 1). Members of the Federal Open Market Committee (FOMC), the central bank's policymaking arm, have often referred to this deliberate lowering of the monetary tar- Requested: get ranges as a signal of the Federal Reserve's long-term policy objective to gradually lower inflation. Please send corrected mai Iing label to the above address. This Economic Commentary reviews the use of the M2 target in recent years and discusses the long-term stance of monetary policy in 1989. We also explain why leaving the target for M2 Material may be reprinted provided that the source is credited. Please send copies of reprinted materials to the editor. ISSN 0428- t 276 unchanged for the coming year may still be consistent with continued disinflation. • The M2 Target as a Short-Term Guide The short-term effect of monetary policy depends importantly on economic conditions. Because information about economic conditions, including the status of policy goal variables, typically arrives with a lag, policymakers use targets and indicators to help them adjust policy in the near term. In the early 1980s, the Federal Reserve relied heavily on monetary targets to guide policy. Since 1984, the FOMC has not placed strong reliance on monetary targets as early warning signals about when to change its policy stance. In fact, the deviation of M2 from the midpoint of its target range has been a contrary indicator of policy actions for most of the - As 1989 comes to an end, the levels of nominal GNP and the M2 aggregate seem to be in balance, as M2 growth has slowed to a 4 to 5 percent range in the past three years. The Federal Reserve's tentative target range for M2 growth in 1990 permits ample op- portunity for the inflation rate to decline in the next few years. cent in 1987 and grew 5.2 percent in 1988. M2 was below the midpoint of its target range in these years, yet the federal funds rate and the discount rate rose steadily. Since 1982, the official target for open market operations has been the level of seasonal plus adjustment borrowing by banks at the discount window. At a range, plotted with the monthly changes in the federal funds rate and the discount rate? M2 grew very rapidly: 8.9 percent in 1985 and 9.4 percent in given discount rate, the lower the borrowing target, the easier the monetary policy. Again, except for some technical adjustments in 1985, the relationship between changes in the borrowing target and deviations of M2 from its midpoint shows that the Federal Reserve did not base its policy actions 1986. The aggregate was well above the midpoint of its target range throughout 1985 and 1986, yet the federal funds rate and the discount rate declined solely on the M2 target. The borrowing target was generally lowered when M2 was indicating rapid monetary expansion, and it was raised when M2 was throughout the period. growing below the midpoint of its target range. last five years. Figure I shows the monthly deviations of M2 from the midpoint of its target In 1987 and 1988, the patterns were reversed. M2 growth slowed to 4.0 per- FIGURE In every instance between December 1984 and June 1989, the M2 aggregate was above the midpoint of its target range when the FOMC decided to ease policy and was below the midpoint 1 Percent of M2 3~--------------------------------------~ M2 DEVIATION FROM MIDPOINT 2 when it decided to tighten the money supply. Clearly, M2 did not play an important role as a short-term guide for policy. -1 In a break with this pattern, the FOMC's easing in the summer of 1989 was attributed partly to the slow growth in the monetary aggregates. Federal -2 -3 -4~~~~~~~~~~~~~~~UL~~~UL~~ Reserve Chairman Alan Greenspan stated, "While the monetary aggregates may not be preeminent on this list [of economic and financial indicators], they Average monthly change in basis points 100~------~~~==------------------------~ Average monthly change in basis points 100~----------------------------------------~ 1987 SOURCE: Board of Governors of the Federal Reserve System. M2 TARGETS Year Target Range" 1985 1986 1987 6 to 9 6 to 9 5.5 to 8.5 AND GROWTH Actual Growth 8.9 9.4 4.0 Year 1988 1989 I990c a. Target ranges are specified for growth from the fourth-quarter quarter average in the target year. b. Growth through September 4 to 8 3 to 7 3 to 7 Actual Growth 5.2 4.0b average in the previous year to the fourth- testimony. Board of Governors of the Federal Reserve System, Monetary Policy Objectives, various years. 7.2 6.9 6.6 Monetary ... . •• base. _•••-.•• 6.3 .. ••••••• 6.0 MI .' 5.7 • 5.1 The objective of monetary policy is to " ...maximize sustainable economic This statement suggests that money growth must show extreme behavior for an extended period before it be- The quantity theory of money states that, over the long run, prices will rise in proportion with the rise in the money supply. According to this comes an overriding consideration for policy. However, the extremely high money growth rates in 1985 and 1986 did not induce the FOMC to tighten theory, the government's supply of money is the most important determinant of the price level. The theory does not deny that many other factors policy. Rather, as long as current data showed moderate inflation and spending, the FOMC allowed money growth may shift the price level. It does say, however, that a doubling of the money stock should eventually lead to a doubling of the price level. 1964 1969 1974 1979 1984 1989 Board of Govemors of the Federal Reserve System. This one-for-one ratio assumes that output and technology in the payments system remain unchanged. If output is growing, then some monetary growth people have developed ways to economize on cash balances, from credit cards for households to sophisticated cash managers for corporate treas- growth, which in tum requires the achievement of price stabi lity over time."s Economists do not have good models to predict how changes in monetary policy will affect real growth in the short run, but many think that the optimal level of growth is attained with price stability and that any long-term deviation from price stability will tend to depress output below its potential level. As a first approximation, we treat the output growth trend as if it is inde- To achieve price stability, the Federal Overall, changi ng monetary institutions have had more effects on some monetary aggregates than on others. A Reserve must reduce the trend in M2 so that it matches the trend growth in the real economy. By examining trends in M2 and nominal GNP, we can form growing body of research suggests that M2, among the official monetary aggregates, is the measure of the money supply that most closely conforms to spending had begun to slow. Even now, we do not know how important slow M2 growth per se was in the decision to is needed just to keep the price level from falling. One way to take account of this real output growth is to examine the relationship between money and various monetary aggregates are plotted with nominal GNP for the ease policy at midyear. Was M2 used as an explanation for policy actions because it happened to move in tandem with the reports of weakening economic nominal GNP. In an economy such as ours, with growing output and a longrun income-elasticity of money equal to unity, the quantity theory predicts period 1959:Q I to 1989:Q2. The series were normalized to 100 in 1959:Q I. activity and peaking inflation, or as a that nominal GNP will rise in proportion with the rise in the money supply. Changes in monetary institutions can also affect this one-for-one ratio. As Policy Implications uries, the ratio of transaction balances to nominal GNP has fallen. This falling trend was halted when banks and savings and loan associations began to pay interest on checking accounts. the predictions of the quantity theory." Figure 2 illustrates that M2, alone among the aggregates, shares a common trend with nominal GNP. The long-term empirical links with inflation and income growth? can be followed by periods of very slow M2 growth without appearing to have much effect on nominal GNP growth. The quantity theory of money explains this common trend. It also implies that the Federal Reserve can control the trend in nominal GNP by controlling the trend in M2. 5.4 • The M2 Target as a Long-Term Indicator basis for policy actions because of its 1989 over 1988:Q4. c. Tentative range specified in the July 1989 Humphrey-Hawkins SOURCE: Target Range" AGGREGATES Natural log 7.5 ~--------------------------------------~ SOURCE: By the summer of 1989, monetary growth had been nearly flat for six RATES (Percent) GNP AND THE MONETARY and relative to our announced ranges. Thus, the very sluggish growth in M2 for the year to date was an important influence in the decision to ease policy in June and July.',3 months. Both inflation and aggregate TABLE 1 FIGURE 2 NOMINAL always receive careful consideration in our policy decisions. This is especially true when they exhibit unusual strength or weakness relative' to past patterns to accelerate. When inflation began to rise in 1987, the rapid money growth was brought to an abrupt halt. 1988 - Although M2 and nominal GNP trends can diverge for a number of years, we expect the series to come together again eventually. Periods of very rapid M2 growth, such as in 1985 and 1986, The figure shows that both M I and the monetary base grew well below the trend in GNP. M2 grew at the same average rate, crossing the GNP series several times. M3 grew above the trend in nominal GNP. pendent of policy and somewhere in the neighborhood of 2 V2 to 3 percent per year. an estimate of the current long-run policy stance or the implied inflation trend. M2 grew by 4 percent in 1987 and by 5.2 percent in 1988. This year, growth will most likely be between 4 and 5 percent. This three-year growth pattern was needed to prevent an acceleration of inflation following the extremely rapid monetary growth in 1985 and 1986. The levels of nominal GNP and M2 seem to be in a kind of balance as 1989 comes to an end (see figure 2). Historical relationships would suggest that continued M2 growth in the 4 to 5 percent range (the midpoint of the target range for 1990) implies an inflation trend of about I to 2 percent. Actual inflation has been averaging about FIGURE In every instance between December 1984 and June 1989, the M2 aggregate was above the midpoint of its target range when the FOMC decided to ease policy and was below the midpoint 1 Percent of M2 3~--------------------------------------~ M2 DEVIATION FROM MIDPOINT 2 when it decided to tighten the money supply. Clearly, M2 did not play an important role as a short-term guide for policy. -1 In a break with this pattern, the FOMC's easing in the summer of 1989 was attributed partly to the slow growth in the monetary aggregates. Federal -2 -3 -4~~~~~~~~~~~~~~~UL~~~UL~~ Reserve Chairman Alan Greenspan stated, "While the monetary aggregates may not be preeminent on this list [of economic and financial indicators], they Average monthly change in basis points 100~------~~~==------------------------~ Average monthly change in basis points 100~----------------------------------------~ 1987 SOURCE: Board of Governors of the Federal Reserve System. M2 TARGETS Year Target Range" 1985 1986 1987 6 to 9 6 to 9 5.5 to 8.5 AND GROWTH Actual Growth 8.9 9.4 4.0 Year 1988 1989 I990c a. Target ranges are specified for growth from the fourth-quarter quarter average in the target year. b. Growth through September 4 to 8 3 to 7 3 to 7 Actual Growth 5.2 4.0b average in the previous year to the fourth- testimony. Board of Governors of the Federal Reserve System, Monetary Policy Objectives, various years. 7.2 6.9 6.6 Monetary ... . •• base. _•••-.•• 6.3 .. ••••••• 6.0 MI .' 5.7 • 5.1 The objective of monetary policy is to " ...maximize sustainable economic This statement suggests that money growth must show extreme behavior for an extended period before it be- The quantity theory of money states that, over the long run, prices will rise in proportion with the rise in the money supply. According to this comes an overriding consideration for policy. However, the extremely high money growth rates in 1985 and 1986 did not induce the FOMC to tighten theory, the government's supply of money is the most important determinant of the price level. The theory does not deny that many other factors policy. Rather, as long as current data showed moderate inflation and spending, the FOMC allowed money growth may shift the price level. It does say, however, that a doubling of the money stock should eventually lead to a doubling of the price level. 1964 1969 1974 1979 1984 1989 Board of Govemors of the Federal Reserve System. This one-for-one ratio assumes that output and technology in the payments system remain unchanged. If output is growing, then some monetary growth people have developed ways to economize on cash balances, from credit cards for households to sophisticated cash managers for corporate treas- growth, which in tum requires the achievement of price stabi lity over time."s Economists do not have good models to predict how changes in monetary policy will affect real growth in the short run, but many think that the optimal level of growth is attained with price stability and that any long-term deviation from price stability will tend to depress output below its potential level. As a first approximation, we treat the output growth trend as if it is inde- To achieve price stability, the Federal Overall, changi ng monetary institutions have had more effects on some monetary aggregates than on others. A Reserve must reduce the trend in M2 so that it matches the trend growth in the real economy. By examining trends in M2 and nominal GNP, we can form growing body of research suggests that M2, among the official monetary aggregates, is the measure of the money supply that most closely conforms to spending had begun to slow. Even now, we do not know how important slow M2 growth per se was in the decision to is needed just to keep the price level from falling. One way to take account of this real output growth is to examine the relationship between money and various monetary aggregates are plotted with nominal GNP for the ease policy at midyear. Was M2 used as an explanation for policy actions because it happened to move in tandem with the reports of weakening economic nominal GNP. In an economy such as ours, with growing output and a longrun income-elasticity of money equal to unity, the quantity theory predicts period 1959:Q I to 1989:Q2. The series were normalized to 100 in 1959:Q I. activity and peaking inflation, or as a that nominal GNP will rise in proportion with the rise in the money supply. Changes in monetary institutions can also affect this one-for-one ratio. As Policy Implications uries, the ratio of transaction balances to nominal GNP has fallen. This falling trend was halted when banks and savings and loan associations began to pay interest on checking accounts. the predictions of the quantity theory." Figure 2 illustrates that M2, alone among the aggregates, shares a common trend with nominal GNP. The long-term empirical links with inflation and income growth? can be followed by periods of very slow M2 growth without appearing to have much effect on nominal GNP growth. The quantity theory of money explains this common trend. It also implies that the Federal Reserve can control the trend in nominal GNP by controlling the trend in M2. 5.4 • The M2 Target as a Long-Term Indicator basis for policy actions because of its 1989 over 1988:Q4. c. Tentative range specified in the July 1989 Humphrey-Hawkins SOURCE: Target Range" AGGREGATES Natural log 7.5 ~--------------------------------------~ SOURCE: By the summer of 1989, monetary growth had been nearly flat for six RATES (Percent) GNP AND THE MONETARY and relative to our announced ranges. Thus, the very sluggish growth in M2 for the year to date was an important influence in the decision to ease policy in June and July.',3 months. Both inflation and aggregate TABLE 1 FIGURE 2 NOMINAL always receive careful consideration in our policy decisions. This is especially true when they exhibit unusual strength or weakness relative' to past patterns to accelerate. When inflation began to rise in 1987, the rapid money growth was brought to an abrupt halt. 1988 - Although M2 and nominal GNP trends can diverge for a number of years, we expect the series to come together again eventually. Periods of very rapid M2 growth, such as in 1985 and 1986, The figure shows that both M I and the monetary base grew well below the trend in GNP. M2 grew at the same average rate, crossing the GNP series several times. M3 grew above the trend in nominal GNP. pendent of policy and somewhere in the neighborhood of 2 V2 to 3 percent per year. an estimate of the current long-run policy stance or the implied inflation trend. M2 grew by 4 percent in 1987 and by 5.2 percent in 1988. This year, growth will most likely be between 4 and 5 percent. This three-year growth pattern was needed to prevent an acceleration of inflation following the extremely rapid monetary growth in 1985 and 1986. The levels of nominal GNP and M2 seem to be in a kind of balance as 1989 comes to an end (see figure 2). Historical relationships would suggest that continued M2 growth in the 4 to 5 percent range (the midpoint of the target range for 1990) implies an inflation trend of about I to 2 percent. Actual inflation has been averaging about December I, 1989 4 percent. Barring a shift in the relation- • ship between M2 and nominal GNP growth, a period of disinflation may lie ahead. 1. See the Federal Reserve Bulletin, any and a Test of the Quantity Theory of The current target range permits ample opportunity for the inflation rate to decline during the next few years. M2 growth would have to be maintained at 7 percent in the future, the upper limit of the range, just to maintain the current inflation trend. The pause in the gradual reduction of the target ranges for 1990 does not imply less commitment to price stability; rather, growth near the midpoint of the current 3 to 7 percent target range would be consistent with further declines in the rate of inflation to about 2 percent, or half of its recent trend. Footnotes recent issue, for definitions of the monetary Money," Working Paper 89-2, Federal aggregates. Generally, M I includes balances Reserve Bank of Richmond, April 1989; and used in making transactions, while M2 in- Robert H. Rasche, "P-Star Type Models: cludes M I plus household savings assets. Evaluation and Forecasts," manuscript, M3, the broadest measure, adds to M2 other Michigan State University, September 1989. liquid assets that are held mostly by large For a less technical description of this work, asset holders. see John B. Carlson, "The Indicator P-Star: 2. The federal funds rate is indirectly, but Just What Does It Indicate?" Economic Com- closely, controlled by the Federal Reserve over periods as short as a month or even a week. The discount rate is set directly by the Board of Governors of the Federal Reserve S. Congressional testimony of Alan Greenspan, Chairman, Board of Governors of the System. Federal Reserve System, July 20, 1989,1989 3. Congressional testimony of Alan Green- Monetary Policy and the M2 Target Monetary Policy Objectives, ~ I p. I. by Susan A. Black and William T. Gavin I span, Chairman, Board of Governors of the Federal Reserve System, July 20, 1989, 1989 Hi;toriCallY, the monetary targets have been used both as a way to signal intentions about long-term policy goals and as a guide for short-term policy actions. I The Federal Reserve has never Monetary Policy Objectives, p. 4. 4. See Robert F. Engle and C.W.J. Granger, "Cointegration and Error Correction: Repre- Susan A. Black is an economic analyst and sentation, Estimation. and Testing," Econo- William T. Gavin is an assistant vice presi- metrica, March 1987.55. dent and economist at the Federal Reserve pp. 251-76. They show that. of all the official monetary aggre- 1990 target ranges at its February 1990 meeting. M2 growth has been averaging nearly 7 percent for the past few months and is expected to continue growing that rapidly. For the FOMC to gates, only M2 shares a common trend with factors become relevant and compel the FOMC to override the signal from M2 remains to be seen. Federal Reserve Bank of Cleveland mentary, Federal Reserve Bank of Cleveland, September IS, 1989. The FOMC will reconsider its tentative maintain M2 growth along a disinflationary track, a tightening of monetary policy would be necessary to constrain M2 to its midpoint. Whether additional eCONOMIC COMMeNTaRY April 1989; Yash P. Mehra, "Cointegration nominal GNP. Recent studies that investigate this result include Jeffrey J. Hallman, Richard D. Porter, and David H. Small, "M2 Per Unit of Potential GNP as an Anchor for the Price Level," Staff Study No. 157, Board of Governors of the Federal Reserve System, Bank of Cleveland. relied solely on the monetary targets to guide policy in the near term, however. The amount of emphasis has varied, first rising as pol icymakers became more concemed about inflation and later fall- The views stated herein are those of the authors and not necessarily those of the Federal Reserve Bank of Cleveland or of the Board of Governors of the Federal Reserve System. ing as evidence mounted that money demand was becoming unpredictable. April 1989; Dennis Hoffman and Robert H. Rasche, "Long-Run Income and Interest Elas- From late 1984 until the summer of ticities of Money Demand in the United States," NBER Working Paper No. 2949, 1989, M2 was the Federal Reserve's primary monetary target, but apparently Iittle attention was paid to it as a near-term guide for policy. M2 targets may still be important, however, as a signal of long-term policy intentions. Federal Reserve Bank of Cleveland Research Department P.O. Box 6387 Cleveland, OH 44101 Address Correction In 1985 and 1986, the Federal Reserve set a target range for M2 of 6 to 9 percent. The target range was lowered BULK RATE U.S. Postage Paid Cleveland,OH Permit No. 385 each succeeding year until July 1989, when the preliminary targets were chosen for 1990 (see table 1). Members of the Federal Open Market Committee (FOMC), the central bank's policymaking arm, have often referred to this deliberate lowering of the monetary tar- Requested: get ranges as a signal of the Federal Reserve's long-term policy objective to gradually lower inflation. Please send corrected mai Iing label to the above address. This Economic Commentary reviews the use of the M2 target in recent years and discusses the long-term stance of monetary policy in 1989. We also explain why leaving the target for M2 Material may be reprinted provided that the source is credited. Please send copies of reprinted materials to the editor. ISSN 0428- t 276 unchanged for the coming year may still be consistent with continued disinflation. • The M2 Target as a Short-Term Guide The short-term effect of monetary policy depends importantly on economic conditions. Because information about economic conditions, including the status of policy goal variables, typically arrives with a lag, policymakers use targets and indicators to help them adjust policy in the near term. In the early 1980s, the Federal Reserve relied heavily on monetary targets to guide policy. Since 1984, the FOMC has not placed strong reliance on monetary targets as early warning signals about when to change its policy stance. In fact, the deviation of M2 from the midpoint of its target range has been a contrary indicator of policy actions for most of the - As 1989 comes to an end, the levels of nominal GNP and the M2 aggregate seem to be in balance, as M2 growth has slowed to a 4 to 5 percent range in the past three years. The Federal Reserve's tentative target range for M2 growth in 1990 permits ample op- portunity for the inflation rate to decline in the next few years. cent in 1987 and grew 5.2 percent in 1988. M2 was below the midpoint of its target range in these years, yet the federal funds rate and the discount rate rose steadily. Since 1982, the official target for open market operations has been the level of seasonal plus adjustment borrowing by banks at the discount window. At a range, plotted with the monthly changes in the federal funds rate and the discount rate? M2 grew very rapidly: 8.9 percent in 1985 and 9.4 percent in given discount rate, the lower the borrowing target, the easier the monetary policy. Again, except for some technical adjustments in 1985, the relationship between changes in the borrowing target and deviations of M2 from its midpoint shows that the Federal Reserve did not base its policy actions 1986. The aggregate was well above the midpoint of its target range throughout 1985 and 1986, yet the federal funds rate and the discount rate declined solely on the M2 target. The borrowing target was generally lowered when M2 was indicating rapid monetary expansion, and it was raised when M2 was throughout the period. growing below the midpoint of its target range. last five years. Figure I shows the monthly deviations of M2 from the midpoint of its target In 1987 and 1988, the patterns were reversed. M2 growth slowed to 4.0 per-
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